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POLITICO LIVE: GOP infighting

Fiscal cliff: A primer

But the tax-free part is coming under greater scrutiny, as Congress looks under every couch cushion for the dollars needed to strike a deal on the looming fiscal cliff, and possibly re-write the tax code next year.

It’s been a frequent target of would-be budget reformers across the political spectrum, including the Simpson-Bowles Commission and the Center for American Progress. Even President Barack Obama has eyed changes to the rules governing 401(k)s.

The American Society of Pension Professionals & Actuaries is worried enough that Congress might further cap the money employees can shelter in 401(k)s that it launched a six-figure social media campaign last week to remind lawmakers of its value.

“The single most important factor in determining if a worker is saving for retirement is whether or not there is a plan at work,” said Brian Graff, ASPPA’s executive director and CEO. “We understand Congress needs to reduce the debt and raise revenue but raiding the tax incentives for 401(k) plans will put American workers’ retirement security at risk.”

The taxes deferred every year through 401(k)s, as as well individual retirement accounts and other employer pension plans, constitute the second largest tax “expenditure” in the tax code — a tax loophole, in the minds of many, and a tempting target.

If the government forced workers to immediately pay tax on the earnings they put in these accounts, the government could put $162.7 billion back into its coffers, in 2014 alone, according to the Joint Committee on Taxation figures.

As ingrained as the 401(k) has become in the U.S. workplace, history shows that defenders of the retirements savings tax break have ample reason to be worried. The pool of tax-deferred savings was targeted in the last major tax reform effort in 1986. Lawmakers left the tax break intact, but imposed limits.

And as lawmakers in both parties look to place more of the tax burden on the wealthy, it’s no secret that retirement tax breaks tend to disproportionately benefit upper-income earners.

Congress created tax benefits for 401(k)s — named after its section in the IRS code — in 1978 as part of a larger tax measure passed that year. But it took another two years and an imaginative benefits consultant to discover that wording from the IRS allowed workers to save pre-tax salary and deferred-bonus plans toward retirement on a tax-deferred basis.

When the Reagan administration realized how much revenue was lost annually by allowing workers to pay taxes on their savings after retiring and moving into a lower income bracket, it tried to eliminate the preference. A public outcry saved the tax break, but provisions imposing new coverage tests were included in the sweeping 1986 tax reform bill. Graff estimates those changes caused thousands of employers and employees to terminate their pension plans.

These days, the majority of American workers doubt their retirement savings will be enough to cover basic needs. And more than 80 percent of workers who have access to a 401 (k) use it — and most of those who don’t have access to one don’t save.

Under current law, workers can save $17,000 annually on a tax-deferred basis. That number is set to increase next year by $500. The IRS taxes the money when a person accesses it in retirement — a point at which most workers have dropped into a lower income tax bracket.

Readers' Comments (18)

Um, hello PoliticoPro! These are legal deductions under the US Tax Code. Can you say "LEGAL DEDUCTIONS".

Just because you want to confiscate our hard earned money and planned for retirement does not make it a "Loophole". You probably couldn't tell a loophole from a tax deduction because you file a 1040EZ.

Move to France if you want to pay 75% tax on high income earners. Stay out of my wallet.

Congress should look at taxing stock transactions. A 1% tax fee on all those high frequency computer trades should bring in a bundle.

There should be a third class of capital gains, we currently have long term and short term capital gains, the third should be up to 70% for stocks held less than 30 days. If you tax the profit out of it the big banks will stop buying and selling millions of shares a day.

The best way to encourage savings and investments is to not tax interest and dividends and eliminate the mortgage interest deduction.

Capital Gains could be allocated between taxable and tax exempt using the mid month convention for five years. Set the maximum net capital gains rate at the average rate of taxation before net capital gains. Eliminate N O L carry back, only allow carry forwards.

Consider a Ralph Nader type solutions, 0.25% tax on publicly traded securities. With a tax credit for the excess of the spread be between and purchase and sale times 35%. If there is a loss, then the full amount would be available against the income tax.

I'm 34. What is a pension? I have a rolled-over traditional IRA that got crushed down to mid 4-digits in 2009. I'm enrolled in my employer's 401(k) plan that has a 25% match, and caps the match to contributions up to 6% of income. Including the match, I'm socking away roughly $5k a year in tax deferred retirement savings, and after fees my plan's annual rate of return is between 3.4%-6.0%. Because I'm enrolled in the 401(k) plan, I don't get any more tax benefit for additional IRA contributions.

Social security eligibility age and benefits are now "on the table" for people of my age. Medicare benefits & eligibility age is now "on the table" for people of my age. Now the deferred taxes (it's not tax free) on my underwhelming retirement savings is "on the table".

Are Baby Boomers the only people who get to retire in America?

It's starting to look like the path for my generation (and for our children) to have some financial & economic security is to take our retired parents & grandparents down to the river and drown them.

The discussion about rationalizing the catastrophic condition of the federal government's fiscal accounts should focus mostly on the weakest area, the entitlement programs, which have many $tens of trillions of unfunded liabilities.

jm wrote: "Leave this tax deduction alone, many companies don't offer pensions anymore and the working class needs to put money away for their old age."

You don't get it, Jason.

This is a two-fer for the "Progressive" agenda, first by taking more money from the people who earn it, and second by reducing the power of the individual to run his or her own life.

If your voluntary retirement deduction is cut, then the government will have more power over you -- they will buy your votes with your grandchildren's money, and punish you if you try to leave the plantation.

Oh why not why don't you friggen idiots go ahead and attack people's retimrement as well, since most of the Oslob voters don't bother to even save for retirement, one more shining example of redistribution under this coward.

Let's make sure that our wonderful Congress-persons TAX their OWN High Flying Benefit packages and that of past Presidents as well. The cost to US Taxpayers by the Glaring Omissions of House, Senate, and WH Perks and Retirement and healthcare packages is large indeed.

While we are at it let's also ensure the Congress can no longer exempt itself from any of the laws they pass, esp. tax laws. Like ObamaCare.

an even better Idea would be to actually tax the bottom 50% of the Taxpayers that only contribute less than 4% of the total tax revenues but who receive the overwhelming benefits of major tax deductions and other perks.

"Because I'm enrolled in the 401(k) plan, I don't get any more tax benefit for additional IRA contributions."

You can contribute to both your 401(k) and and IRA as long as your income isn't over a certain limit. And you are right to be concerned about your retirement. It appears EVERYTHING is on the table but tax increases on the richest Americans. There is NOTHING for the middle class that is NOT on the table.